What is Financial Literacy, Why It Matters
Do you ever feel intimidated or overwhelmed when managing your finances? You’re not alone. Financial literacy — the ability to understand and manage our personal finances — is an oftentimes-overwhelming concept that many of us struggle with. But it’s so critically important! Understanding and taking control of our money plays a vital role in achieving financial security, reaching life goals, and feeling confident about our financial decisions.
In this post we’ll break down what exactly financial literacy means, explain why it matters for everyone, and provide clear steps for how to get started improving your own level of financial savvy today.
What Is Financial Literacy?
Financial literacy is the ability to understand and manage your money, including personal financial management, budgeting, and investing. Financial literacy is the cornerstone of your relationship with money and it’s a journey you’ll be on for life. Learning early will put you ahead because when it comes to success with money, education is key.
Why is Financial Literacy Important
Individuals who lack financial literacy can be at a disadvantage when it comes to long-term financial success. According to studies, a majority of Americans have poor money management skills. The Financial Industry Regulatory Authority (FINRA) has pegged the number at 66%.
People who are not financially literate often make bad decisions that lead to things like being in too much debt, which then results in a bad credit score, possible bankruptcy, and losing their home.
What are the Five Pillars of Financial Literacy?
To be financially literate, one should understand how to earn, spend save, borrow and protect their money. Other models may have different key components but the goal remains educating individuals so that they can make responsible decisions with their money.
Download our Free Personal Finance Cheat Sheet
How Financial Literacy Works
Your journey to financial literacy starts with your first interactions with money, and it’s a lifelong process that will have good and bad moments. You can improve your financial literacy by reading books or articles about personal finance, but you’ll learn the most from real-life experiences.
To have financial literacy is to understand the ins and outs of any money-related decision, big or small. This doesn’t mean that you need to be a walking dictionary on all things money, but rather that you’re confident enough in your ability find answers and make financially wise decisions.
Here are some questions financially literate people often ask themselves when faced with a money decision:
- How much does this cost?
- How what are the short-term and long-term costs?
- What are the rules that apply to this choice? (Are there fees?)
- What am I sacrificing by using my money for this, and what will I gain in return?
- Could I afford to lose this money if the decision turned out to be a poor one?
Financial literacy not only encompasses an understanding of personal finance products such as checking accounts and credit cards, but also how to calculate fees and interest. Additionally, fundamental concepts of financial literacy include learning about credit, budgeting, and investing.
Benefits of Financial Literacy
Generally, financial literacy leads to individuals making wiser decisions. Nevertheless, there are several other reasons why being financially literate is essential:
Financial literacy can help you prevent making costly financial mistakes
Poor financial decision-making can have major consequences down the line, costing individuals money or throwing off their life plans. Financial literacy gives people the skills they need to make sound decisions with their personal finances and avoid these costly mistakes.
Financial literacy prepares you for an emergency
Learning about financial literacy topics such as saving or emergency preparedness can help individuals be ready for the uncertain. Though losing a job or having a major unexpected expense are always financially impactful, an individual can cushion the blow by implementing their financial literacy in advance and being prepared for emergencies.
Financial literacy can help you reach your goals
If you want to achieve your financial goals, whether they seem impossible or not, it’s important to understand how budgeting and saving work. By making a plan that includes these concepts and holding yourself accountable, you increase your chances of success astronomically.
Financial literacy will give you confidence
It’s difficult to make well-informed decisions without complete knowledge. However, if you’re armed with the right financial information, you can approach life’s major choices with more confidence and avoid negative surprises.
How to improve your Financial Literacy
A variety of skills go into financial literacy, such as budgeting, debt management and pay-off, credit comprehension, and investment product knowledge.
Money management is a combination of developing abilities and following certain procedures with the goal of fostering good financial health. To become financially literate, you must learn skills related to aspects such as creating and adhering to a budget, managing debts, and understanding credit products and investment opportunities, among others.
Here are 7 things you can do to improve your personal financial literacy
Create a Budget
Keep close track of your monthly finances by recording income and expenses in an Excel sheet, on paper, or with a budgeting app. This budgetary record should include: money coming in (i.e. paychecks, investments, alimony), fixed outgoing payments (rent/mortgage, utilities, loan repayments), discretionary spending (non-necessities such as restaurants, entertainment
Check out our Ultimate Guide to Budgeting and download our Free Monthly Budget Worksheet.
Make sure you have a savings strategy, including having an emergency fund set aside with 3-6 months of expenses saved. Then set financial goals and create a savings plan, and put that money away first each month before you think about discretionary spending.
Pay Bills on Time
One of the best ways to be consistent with monthly bills is to take advantage of automatic debits from a checking account. You can also set up payment reminders (by email, phone, or text) so you never forget another bill again.
Check Your Credit Report Regularly
Consumers are entitled to one free credit report from each of the three major credit bureaus—Experian, Equifax, and TransUnion—every year. These reports can be accessed through AnnualCreditReport.com, a website created by the government. If you find any errors on your report, reach out to the credit bureau and explain what is inaccurate.
Check Your Credit Score Regularly
Credit scores are important for getting the best interest rates on loans and credit cards, among other things. You can check your score for free with a credit monitoring service (or, if you want an extra layer of protection, use one of the best paid credit monitoring services). Be aware of the financial decisions that can raise or lower your score – such as taking out new lines of credit or having high balances on existing accounts.
Learn more about credit scores
Use your budget to stay on top of debt by reducing spending and increasing repayment. Develop a debt-reduction plan, such as paying down the loan with the highest interest rate first. If your debt is excessive, contact lenders to renegotiate repayment, consolidate loans, or find a debt-counseling program.
If your employer offers a 401(k) retirement savings account, be sure to sign up and contribute the maximum to receive the employer match. Consider opening an individual retirement account (IRA) and creating a diversified investment portfolio of stocks, fixed income, and commodities. If necessary, seek financial advice from professional advisors to help you determine how much money you will need to retire comfortably and develop strategies to reach your goal.
Improving your financial literacy is a process that takes time, but it’s worth it. By gaining a better understanding of money and how it works, you can make more informed decisions about your finances. Financial literacy can also help you reach your financial goals and build wealth over time. If you’re ready to get started, there are plenty of resources available to help you improve your financial literacy. You can check out more resources below to start improving your financial literacy today!
Free Personal Finance Cheat Sheet
Ultimate Guide to Budgeting
Free Monthly Budget Worksheet
How to Save for Retirement
Top 3 Bad Money Habits that are Sabotaging Your Finances
How to Talk About Money with Your Partner